Saving For College: A Parent’s Guide To Federal Tax Incentives
Sanjiv Gupta CPA - 6 years ago
When your child receives the college acceptance letter in the mail from their dream school, the only thing that could make you happier is knowing that they will have the financial resources to pay for the college of choice.The cost of college for your child(ren) might be the largest expenditure you ever have. Millions of other parents face this same challenge. The good news is there are more options to save for future college expenses than ever before. The traditional investment options – taxable investment accounts, savings accounts, United States Savings Bonds and annuities – are joined with new education savings vehicles including Coverdell education savings accounts and Section 529 college savings programs.While these new investment education programs bring new opportunities, they can also make a parent’s decisions much more difficult. Understanding all of the available options is the best way to maximize the return on each dollar you save for your child’s future. It is important to remember that even though saving for your child’s education may seem overwhelming now, with savings and proper planning, college costs can be within your reach.One of the best ways to make your child’s education more affordable is to take advantage of some of the federal tax breaks geared toward savings and reducing the cost of college including:529 Plans (Qualified Tuition Programs): Tax-deferred earnings. When distributions are taken for qualified post-secondary education costs, they are tax-free.Coverdell Education Savings Accounts: Tax-deferred earnings. When distributions are taken for qualified post-secondary education costs, they are tax-free. Withdrawals from education savings accounts are also tax-free when they are taken for primary and secondary school expenses.United States Savings Bonds: I and EE savings bonds that were purchased after 1989, by someone 24 years or older, maybe redeemed tax-free for college tuition and fees for the bond owner, dependents or their spouse. The tax exclusion, in 2014, is phased out for those with incomes from $76,000 to $91,000 (for married filing jointly the incomes are phased out from $113,950 to $143,950). Each year, income levels increase.Individual Retirement Accounts: With traditional IRAs and Roth IRAs, the penalties for early withdrawals are waived when the funds are used to pay qualified post-secondary education costs for the account holder, dependants, their spouse or grandchildren. However, taxes for the withdrawal may still be due.American Opportunity Tax Credit: Available through 2017. Parents can claim a tax credit for their dependent children’s college tuition and fees equaling 100% of the first $2,000 and 25% of the following $2,000 ($2,500 maximum per child). If the student is not claimed by someone else as a dependant, they can claim the American Opportunity Credit themselves. The tax credit is phased out with incomes from $80,000 to $90,000 (for married filing jointly it is phased out from $160,000 to $180,000). The tax credit is only available when students attend a college degree program half-time or more and if they have not completed 4 years before the beginning of the tax year. The American Opportunity Credit cannot be taken more than 4 tax years. Lifetime Learning Credit: This is a tax credit for 20% of up to $10,000 in tuition and fees for the taxpayer, dependent children or their spouse. This tax credit is phased out in 2014 for incomes from $54,000 to $64,000 (for married filing jointly it is phased out for incomes from $108,000 to $128,000). When a taxpayer claims the Lifetime Learning Credit, they cannot claim the American Opportunity Credit during that tax year. With the Lifetime Learning Credit, there are no enrollment time or degree program requirements. Also, this credit has no limit on the number of years it can be claimed.Student Loan Interest Deduction: An above-the-line deduction may be taken for student loan interest up to $2,500 if the student loan was used to pay the taxpayer, dependent children or their spouse’s college costs. The student must be attending a college degree program at least half-time. In 2014, the deduction is phased out for taxpayers with incomes from $65,000 and $80,000 (for married filing jointly the deduction is phased out for income from $130,000 and $160,000). This deduction cannot be claimed by the student if he/she is a dependant on someone else’s tax return.Tax-Free Education Grants: If the recipient does not provide a service in exchange for the grant, the majority of grants are tax-free.Tax-Free Education Scholarships: If the recipient does not provide a service in exchange for the scholarship, the majority of scholarships are tax-free.Tax-Free Employer Educational Assistance: When an employer provides tuition assistance to an employee, the benefit is tax-free. It can only be used to pay the employees education, not the spouse or dependent children. Education doesn’t have to be related to the job. Also, under a Section 127 educational assistance plan, employers are able to deduct up to $5,250 in tuition and fees for college or graduate school for each employee.Your goal is to afford the college of your child’s choice. You should not look at college costs as another expense, like your rent or electric bill. Think of it as an investment in your child’s future. According to the Census Bureau, college graduates earn 85% or more than those who only have a GED certificate or high school degree. The additional income earnings for people with a college education could exceed $1 million over their lifetime.The best way to make sure that your child has higher education options later is to save now. That way your child can base their college selection on a school that offers the best education, not the school that offers the best financial aid. Knowing that affording their college education will not be dependent on outside sources, like scholarships and loans will put your mind at ease.To maximize your college education savings, there are many vehicles available for you to choose from. It is critical that you select a suitable strategy and combine the best investment vehicles. Take time to carefully evaluate all of your options. It may be helpful to seek professional financial and tax planning advice to develop the best strategy to save for your child’s college education.
A New Tax Strategy For College Expenses
Sanjiv Gupta CPA - 6 years ago
There are a lot of families that make too much money for their beloved child to qualify for college aid that is need-based. The only way they can save money on college expenses is to focus on college tax aid. This is a tax saving that will help parents lower the total college cost. Currently, the stock market is reaching all-time highs. Parents are able to combine any investment gains using this strategy which could wipe out capital gains up to $25,000 during the years that their child is attending college. It is a great way to save for college as well as paying you dividends when you retire. Example of This Tax StrategyYou give your child an investment such as a mutual fund, EFT or appreciated stock. Your child can then use the personal exemption, American Opportunity Tax Credit and standard deduction to offset the $25,000 of long term capital gains for that year. Personal Exemption & Standard DeductionNormally, parents claim the personal exemption ($3,900 for 2013) for their child in college because they provide more than 50% of the support during the year. If your child uses her own assets and income to provide more than 50% of their own support (approximately 50% of the college costs) than they can claim their own personal exemption instead of the parent claiming the exemption.A dependent child standard deduction is the amount of income the child earns from $300 up to $6,100. If your child claims their own personal exemption because he/she provide more than 50% of his/her own support, he/she can get the personal exemption automatically in addition to taking the full standard deduction ($6,100 in 2013) no matter how much income he/she has earned.American Opportunity Tax CreditYour child can claim the American Opportunity Tax Credit if you do not claim this tax credit or claim that child as a personal exemption on your personal tax return. The American Opportunity Tax Credit is worth a maximum of $2,500 for each of the 4 college years. The amount of the tax credit is 100% of qualified tuition, costs, and fees that are paid in addition to 25% of the next $2,000 that was paid.Kiddie TaxAn unearned income that is paid to children under 19 years old or if your child is attending college full time and is under 24 years old is subject to the Kiddie tax. In 2013, the first $1,000 of unearned income is tax-free, the second $1,000 of unearned income is taxed at the child’s tax rate and any other income over $2,000 is federally taxed at the parents’ federal tax rate.A college student can avoid the Kiddie tax by providing more than 50% of his/her own support using earned income such as salary or wages. Understand that the requirement for the Kiddie tax is different from the personal exemption support test.Example of Tax SavingsYou gift your child appreciated assets of $14,000 per year for each permitted donor in 2013 or $28,000 for parents filing jointly. Your child will need to sell some of the assets during the year to pay for his/her own support. Your child realizes $25,000 in long term capital gains. Your child will use the money from selling the assets to enroll in a state university that costs $46,000 every year.Your child will get the personal exemption, standard deduction and use the American Opportunity Tax Credit in order to offset the $25,000 long term capital gains for the year.The personal exemption and standard deduction will reduce the capital gains of $25,000. The remaining taxable income will be $15,000 that will be taxed, under the Kiddie tax, at 15% (which is the parents' capital gains tax rate). The total tax will be $2,250. This will be completely eliminated when the American Opportunity Tax Credit of $2,500 is used.
How to pay for school and college expenses?
Sanjiv Gupta CPA - 1 year ago
Recent high school graduates embarking on their college journey for the first time or students returning to the colleges and universities they are enrolled at all have the same burden – paying for college. This can be quite a daunting task for students and parents that may drill holes in their pockets. Here are tips on education tax benefits that can assist in the offset of college costs.American Opportunity CreditIn various cases, there is credit that offers greater tax savings and also exist in the education tax breaks. Here are some key features of said credit:– Tuition, books, related fees, and other required course materials also qualify. In the past, books were not even eligible for credits and deductions that are related to education.– Credit is often equal to 100% of the $2,000 that is first spent and then 25% of the $2,000 that follows. This amounts to the complete $2,500 credit that is made available to the taxpayer as long as he or she pays the amount of $4,000 to what is considered the qualified expenses for eligible students.– If the student qualifies, he or she can take the credit even if the individual has taken the Hope or Lifetime Learning Credit years before 2009.– The full credit is available for taxpayers who have the MAGO or modified adjusted gross income amounting to $80,000 or less. For married couples who are filing a joint return together, the limit is $160,000. The credit is then phased out for those who pay their taxes with income that is more than this amount. These income limits are also higher than the former Hope and current Lifetime Learning credits.– 40% of the American Opportunity Credit is also refundable. This means that people who do not owe any tax can receive the yearly payment of the credit that can amount to $1,000 for every eligible student. The other existing credits and deductions that are related to education also do not provide the benefit to people who do not owe taxes. The refundable portion of the credit is also made available to students whose investment income has been taxed at the parent’s rate which is also referred to as kiddie tax.A number of taxpayers who pay post-secondary education are eligible for American Opportunity Credit. There are others who do not. The limitations include married couples who are filing separate returns, no matter how much they make. MAGI joint filers earning $180,000 or above that amount are also not qualified. Finally, the single taxpayers, certain widows and widowers with the MAGI of $90,000 or more and heads of households are also not qualified.There are post-secondary education expenses that do not qualify for American Opportunity Credit. These include the expenses that have been paid for students, who at the beginning of the tax year have already completed the four years of college as their credit on their first try and are only granted four years of post-secondary education. For the students who qualify, they can claim for the Lifetime Learning credit instead.Lifetime Learning CreditIf the student fails to qualify for American Opportunity Credit, he or she can qualify for Lifetime Learning Credit. Here are the key features of the credit:– The major difference is that there is no limit on the years that the Lifetime Learning Credit can be claimed as long as the student is eligible.– It is available for the years that the qualified student will take for post-secondary education and courses that are taken in order to improve or acquire job skills.– The qualified student need not be pursuing any degree or a recognized education credential.– The complete credit is available to taxpayers that are declared eligible as long as they make below $52,000 or for married couples filing together – $104,000. Anything above these mentioned amounts results to the credit phasing out quickly.– Expenses that are considered qualified include fees and tuition and books that are related to the course, along with equipment and supplies.– This credit is non-refundable. Therefore, the maximum amount that can be credited is limited to the tax that is paid on the return.– The credit can total up to $2,000 for every student deemed eligible.A student can only claim one kind of education credit for the current tax year. If the college expenses have been paid for more than a student in that year, these students responsible for the payment can take credit. In this situation, one student can claim American Opportunity Credit while the other can obtain the Lifetime Learning Credit. It is important to note that the Lifetime Learning Credit has a cap of $2,000 per tax return.The said credit can be claimed in the individual’s tax return. The individual must have claimed to be exempt as a student. An example of this is when the parents of the students are divorced and the mother claims for the exemption while the father pays for the tuition. The mother will not be able to receive the credit even if the father has made the appropriate payments.Student loan interest deductionGenerally, this is a personal interest that the individuals pay aside from a home mortgage interest. This, however, is not a deductible. Nonetheless, the individual can deduct the interest that has been paid on the student loan that is qualified for the duration of the year. It can also be reduced depending on the income as long as it is subject to tax that reaches the amount of $2,500 even without deductions that are itemized and laid out.Overlooked Ways to Pay College DebtPaying for college is a difficulty for a majority of families and this involves pulling funds from multiple resources, whether it be savings or financial aid. Some parents have already started saving college fund for their children even after they were just born. With many avenues, experts have already acknowledged that it is definitely overwhelming to come up with a financial plan. Whether the child will be heading to college next fall or years from now, here are some ways that have often been overlooked but can definitely cover college costs.Start a 529 PlanIn an ideal scenario, this account should be open even when the child is just young. This is done so that the savings will accrue over a period of time especially if the funds enrolled is an age-based investment. Experts suggest that parents start opening this account even if the student is already in high school.Parents must start saving as early as they can for their offspring’s education. No matter how small the amount is, each cent counts. 529 savings account have tax advantages. This plan is underutilized because not a lot of parents are aware that this is a prospect for paying for college.Applying for a FAFSAFAFSA or Free Application for Federal Student Aid is what determines whether the student qualifies for a scholarship and how much. Filling this out unlocks access to federal aid like Pell Grant or student loans. This is also the form that institutions use so they can deliberate on who among their potential students will receive financial aid.Federal Loan OptionsFederal loans have more flexible repayment options when compared side by side to private loans. An example of this is the Stafford. This is also why students should exhaust the federal options before they even follow from private education loans. However, there are some private student loans that have smaller interest rates than the federal student loans. This also depends on the credit history so the borrower must take into account this factor before even selecting the lender.Financial Aid AwardsColleges, particularly private institutions, must be willing to increase the financial aid packaged based on the need-based aid especially when there is a change in income or there is a special circumstance. There are some situations that the institutions will increase the merit-based aid so that students can enroll in this.ScholarshipStudents can apply for scholarships even when they are already in college. Searching for a scholarship may be a full-time job. Filling out the FAFSA must not be the only action step that students should take. They should not be afraid to go online for random scholarships and go for the one that best fit their profile.There are students who prefer to not rely on their parents for their higher education despite the fact that the latter only want the best for the former. There are some children who feel that it is their responsibility to finance their own education. If this is the case, the student should not drown in debt. Here are ways to prepare for the cost of that degree.Ask parents earlyStudents should not wait in their senior year to inquire from their parents if they are willing to financially contribute for college. If the answer is yes, the student must know how much the parents are willing to offer, whether it be a percentage of the overall cost or the exact dollar amount. It can definitely be an uncomfortable conversation but it is very necessary for the student to know how much support they will be able to receive.The earlier this conversation occurs the better. This gives the student more time on how to go about paying for college.Look into In-State or Community CollegesA community college is a good way to start accumulating those credits and this can be done even before graduating from high school. Doing this can save the student on tuition costs. There are also some students who spend the first two years at a community college and live at home then eventually transfer to a four-year program so that they can save thousands of dollars.In-state colleges are cheaper than out-of-state and private counterparts. For example, the average cost of a community college is $3,520 and tuition at an in-state four-year program is roughly $9,650 whereas a private four-year school can even amount to $33,480.Join the MilitaryThere are students who join the military because they feel that the years of service come with a reasonable trade of graduating college free of debt. For example, the Navy has a sign-on bonus of $40,000 for the College Fund. This added extra money to GI Bill monthly payments.Most branches of the military, including the Air Force, the Navy, the Army, and the National Guard, have education benefits. These cover the over-all costs of the tuition bill along with the loan repayment assistance. It also covers the tuition and $1,000 for every year to pay for the supplies and books.Work During and Even Before CollegeThere are some who work during summer even when they are still in high school. This goes on until they are in college and are home for the summer. Part or full time jobs can already help subsidizing any deficits that are left to cover the college expenses like housing costs and the lifestyle. A gap year before going off to college help position the student in minimizing their debt. There are those who opt to use this time to work and also save for college.As for parents who are more than willing to help pay for their children’s college education, they should already start saving money once the child is born. The cost of college education increases every year and investing in special college savings plan can also help the parents stay ahead of the game so that they are protected against inflation. There are educational plans that provide tax shelters for their funds until the future scholar goes off to college. Then there are also states that offer college savings opportunities, like the Section 529 Education Savings Plan mentioned earlier.Parents can also teach their children financial responsibility. They should have their children be involved in the payment process despite the fact that they have the money to cover the costs. They should let the child understand that it is not a free ride. Encourage them to get a job. Teach them financial responsibility by letting them earn their own money.
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